An initial public offering (IPO) is the moment a private company first sells shares to anyone who wants to buy and starts trading on an exchange. Until then, only private investors, venture funds, employees and founders held it. The offering lets the company raise a lot of money, and lets those who held it until now sell.
The process starts with a prospectus. In the US it is Form S-1 filed with the Securities and Exchange Commission: a long document detailing the business, financial statements, risks and ownership structure. Sometimes the company files it confidentially first and publishes it later. Then come amendments, and in one of them, usually close to the offering, the company publishes the price range: the minimum and maximum it expects per share, and the number of shares it will offer.
Then the roadshow begins. Management, together with the banks running the offering (the underwriters), meets funds, pension funds and large institutional investors and presents the company. Investors submit orders: how many shares they want and at what price. The underwriters collect the orders into a 'book' and, based on demand, set the final price the evening before trading starts.
If demand is especially strong, the final price can be set above the range, and sometimes the company increases the number of shares. If demand is weak, the price is set at the bottom of the range or below it, and in extreme cases the offering is postponed. On the first day of trading, the price is set by the open market. A big first-day jump looks like success, but it also means the company 'left money on the table': it could have sold the shares for more.
Another term worth knowing is the lock-up period: usually, employees and early investors cannot sell their shares in the first months after the IPO. When that period ends, many shares can hit the market at once, and sometimes that pushes the price down. And for anyone considering buying on IPO day: the price institutional investors got the night before is not the price you will get, and history is full of hot offerings that traded below their IPO price a year later.
